Yuan Investors Skirt PBOC Limits

Updated Nov. 27, 2012 10:13 a.m. ET

SHANGHAI—Chinese investors are finding new ways to express optimism about the yuan despite Beijing's tight controls, the latest indication of the increasing divergence between the market and authorities on where they think the Chinese currency should be trading.

Some investors are trying to profit off trades of once little-used short-term yuan forward contracts that effectively allow them to go beyond yuan trading limits set by the People's Bank of China, according to traders who watch China's onshore yuan market. Others are looking at currency pairs other than the yuan-dollar combination, which faces looser limits than yuan trades against currencies like the euro and the yen.

The trading comes as investors are already pushing the yuan to the strongest point allowed by the daily-trading limits set by the central bank, in defiance of its efforts in recent weeks to keep the currency steady against the U.S. dollar. The pressure indicates investors believe the yuan should be stronger than the central bank will allow it to go, amid signs that China's economic growth is picking up again after a lull.

The trades suggest that many yuan sellers are only dealing when prices are higher than those set by the PBOC—and are finding willing buyers, many of them from the corporate world, according to traders. It is a fresh reminder of the challenges faced by Beijing in honoring its long-standing pledge to grant market forces a bigger role in determining the yuan's value.

The PBOC sets a daily rate, called the parity rate, at which the yuan trades onshore versus the dollars. The yuan is then allowed to move 1% in either direction during daily trading. Investors have pushed the yuan to the upper limit of the trading band in 19 of the past 22 sessions starting from Oct. 25, indicating a desire for faster appreciation.

But the yuan is up only 0.4% versus the dollar over the same period, as the PBOC continues to set a relatively steady parity rate. The yuan on Monday finished at 6.2255 to the dollar, again hitting the upper limit.

The restrictions have drawn interest to one-day-long dollar-yuan forwards, which are settled three days after they are sold rather than the two days required to settle on the spot market. The freely traded forward market enables traders to strike deals on yuan at prices higher than the spot exchange rate.

China's central bank releases little in the way of detailed trading data, and the size of such trades is unclear. Traders say that although they see a clear pickup in such trades recently, volumes of these and other alternative trades are smaller than what the spot market sees on a typical day.

"Because the recent dollar selling interest has been very strong, people have started to get around the spot market, which is confined by the 1% band, via the forward market," said Raymond Lo, head of trading at Hang Seng Bank (China) Ltd., adding that such alternative trading solutions are within regulations.

On Monday, the one-day dollar-yuan forward contract was quoted at 6.2240 when the yuan hit the 1% upper limit in the morning, said a Shanghai-based foreign bank trader. That put it 1.03% higher than the day's parity rate, according to Wall Street Journal calculations.

"The one-day forward market was especially active in mid-November, when the yuan had hit the band limit for a while and the market was very confused about where it's going," said Zhao Pengyong, a trader with Sumitomo Mitsui Banking Corp., who is a participant of the one-day forward market.

Those willing to pay a premium for yuan are corporate buyers facing lower liquidity in the onshore market and a need for yuan, traders say.

Another alternative route that traders have taken to unload their dollars is to use the exchange rates between the yuan and other nondollar currencies, like the euro, yen and even the Hong Kong dollar, all of which enjoy a much wider trading band, to indirectly achieve conversion between the Chinese and U.S. currencies.

Traders said unless the PBOC changes its tactic and allow the market to more freely express its more bullish views on the yuan, the currency will frequently hit its daily upper limit, which could force even more investors to look for similar alternative solutions.

Dennis Tan, a foreign-exchange strategist with Deutsche Bank,DB0.78% said he expects the yuan to have a slower pace of appreciation in the next three to six months as domestic inflation will likely stay at low levels.

This copy is for your personal, non-commercial use only. Distribution and use of this material are governed by our Subscriber Agreement and by copyright law. For non-personal use or to order multiple copies, please contact Dow Jones Reprints at 1-800-843-0008 or visit www.djreprints.com.